TAXATION AND TAXATION AND INCOME INCOME

DISTRIBUTIONDISTRIBUTION

14-2

Incidence of Social security (SOC) (COPY)

Who bears the burden? Is SOC direct or indirect tax?

Determinants of incidence (pure PAYGO x FF systems), backward shaped S

Incidence in general equil. models (GEM)

14-3

Vocabulary Statutory Incidence Economic Incidence Tax Shifting Partial (General) Equilibrium Models

Example: VAT in Czech R. VAT agent – who runs the shop and sells goods (seller,

producer) Consumer - me, you if buying something in shop of VAT

agent Who is worse off? Me or seller?

14-4

Tax Incidence: General Remarks Only people can bear taxes

Functional distribution of income (capitalists, labourer) (Q (CIT)) Size distribution of income (rich or poor)

Both sources (PRODUCERS – physical!) and uses (CONSUMERS) of income should be considered

Incidence depends on how prices are determined (see later MONOPOL, or time aspects – long or shor run), Labour Union…

Incidence depends on the disposition of tax revenues (what for the taxes are collected) Balanced-budget tax incidence (Net tax/transfer incidence) Differential tax incidence (One tax is replaced by another tax) Lump-sum tax incidence (One tax is replaced by head tax) Absolute tax incidence (only one tax is changing, ceteris paribus – the

simplest analyses)

14-5

Tax Progressiveness (YES or NO) Can Be Measured in Several Ways…

Average tax rate versus marginal tax rate

Proportional tax system Progressive tax system Regressive tax system

Tax Liabilities under a hypothetical tax system

Income Tax Liability

Average Tax Rate

Marginal Tax Rate

$2,000 -$200 -0.10 0.2

3,000 0 0 0.25,000 400 0.08 0.2

10,000 1,400 0.14 0.2

30,000 5,400 0.18 0.2

14-6

… and unfortunately sometimes with different results. HOW Progressive a Tax System is can be measured by:1/change in ATR if I goes up for 1 OR 2/level of elasticity

vI I

TI

TI

11 0

1

1

0

0

vT T

T

I II

2

1 0

0

1 0

0

14-7

Q: The tax proposal - everyone´s tax liability will increase by 20 %

T = t*TaxBase T´ = 1,2*T calculate v1/v1´ calculate v2/v2´ discuss the impact on progressivity

14-8

Measuring How Progressive a Tax System is – A Numerical Example (2 payers, poor 0 and rich 1)

vI I

TI

TI

11 0

1

1

0

0

v

T TT

I II

2

1 0

0

1 0

0

.0 0 0 2 51 0 0 0 8 0 0

3 0 01 0 0 0

2 0 08 0 0

.0 0 0 31 0 0 0 8 0 0

3 6 01 0 0 0

2 4 08 0 0

2 03 0 0 2 0 0

2 0 0

1 0 0 0 8 0 08 0 0

.

2 03 6 0 2 4 0

2 4 0

1 0 0 0 8 0 08 0 0

.

14-9

Measuring of global progressivity - GINIProperties of inequality metrics

The Gini coefficient satisfies four important principles: Anonymity: it does not matter who the high and low

earners are (man, woman, children, maried…). Scale independence: the Gini coefficient does not

consider the size of the economy (in dollars or in CZK), the way it is measured, or whether it is a rich or poor country on average (v1 does not meet).

Population independence: it does not matter how large the population of the country is.

Transfer principle: if income (less than the difference), is transferred from a rich person to a poor person the resulting distribution is more equal.

14-10

Gini:

n is number of units y is income (ascending manner)

]...)1(**[**

211 21

2nynyny

ynnG

14-11

0.60

0.80

1.00

1.20

1.40

1.60

1.80

2.00

2.20

2.40

2.60

0 1 2 3 4 5 6 7 8

Before Tax After Tax

Consumers Pay

Suppliers Receive

$1.40

$1.00

$1.20

$1.20

D0

S0

D1

S1

Partial Equilibrium Models

Quantity

$

14-12

0.6

0.8

1

1.2

1.4

1.6

1.8

2

2.2

2.4

2.6

0 1 2 3 4 5 6 7 8

DX

S

SX

DX’

PerfectlyInelasticSupply

Quantity

$

14-13

0,6

0,8

1

1,2

1,4

1,6

1,8

2

2,2

2,4

2,6

0 1 2 3 4 5 6 7 8

DX

S

SX

DX’

PerfectlyElasticSupply

Quantity

$

14-14

0,6

0,8

1

1,2

1,4

1,6

1,8

2

2,2

2,4

2,6

0 1 2 3 4 5 6 7 8

DX

SX

DX’

Quantity

$

DX’´ˇ

14-15

Tobacco tax (or green tax reform) paradox

MoF really wants: get some additional money for public budget (but it means no or only small change in consumption). (inelastic d)

On the other side he says to the public to justify - legitimize the new tax: smoking is unhealthy and it is necessary to eliminate this bad habit (it means a large decrease of consumption). (elastic d)

Paradox…

14-16

Absolutely elastic D

Tax T1 on consumers plus absolutely elastic demand

Tax T2 on producer plus absolutely elastic demand

maximum pressure of consumers to producers to preserve effective price unchanged. Tax is shifted on producers. T1 and T2 are equivalent taxes

14-17

Absolutely inelastic D (tobacco)

similar graphic analysis as above We can sum up: there is a minimum pressure

of consumers to produces to preserve effective price unchanged. Tax is shifted on consumers. T1 (consumers) and T2 (producers) are equivalent taxes.

14-18

Inelastic supply (agricultural production, land property activities)

The aim or result – to punish producers We can sum up: there is a minimum pressure

of producers to consumers. Tax is shifted on producers. T1 and T2 are equivalent taxes.

14-19

Elastic supply

The aim or result – discourage the activity, production…

We can sum up: there is a maximum pressure of producers to consumers. Tax is shifted on consumers. T1 and T2 are equivalent taxes

14-20

Ad Valorem Taxes

Pounds of food per year

Pric

e pe

r P

ound

of

food

Df

Sf

Q0QmQr

P0

Pm

Pr

Df’

14-21

Taxes on Factors

The Payroll Tax (see ad valorem tax above) Capital Taxation in

OPEN Economy (Large X small) CLOSED Economy (Large X small)

Commodity Taxation without Competition

Monopoly Oligopoly (a few sellers)

they are able to obtain cartel solution (similar to monopol)

or not because of cheating (similar to perfect competition)

14-23

Monopoly maximizing profit (MR=MC)X0 to X1

X per year

$

DX

MRX

ATCX

MXX

X0

P0

ATC0

a

b

c

d

EconomicProfits

DX’MRX’

Pn igf

h

X1

EconomicProfits

after unittax

X01 X00 (MRx=0)

Pg

14-24

ALTERNATIVE - Unit tax on MONOPOLY(supply side, linear demand)

MC before and after the

tax ATC before and after the

tax

½ T on producer, ½ T on consumer

Profit (decrese of ½

tax)

unit tax

14-25

Monopoly maximizing sales (MR=0)UNIT TAX

X per year

$

DX

MRX

ATCX

MXX

X0

P0

ATC0

a

b

c

d

after tax

DX’MRX’

Pn igf

h

X1

before tax

X01 X00 (MRx=0)

14-26

Monopoly maximizing sales (MR=0)AD VALOREM TAX

X per year

$

DX

MRX

ATCX

MXX

X0

P0

ATC0

a

b

c

d

DX’MRX’

Pn igf

h

X1

MR= 0X00 = X01

X00 = X01 (MRx=0)

14-27

Profits Taxes (Tax baze)

Economic profit (Long X short period) Perfect competition Monopoly

Measuring economic profit (as rate of return , BUT original costs OR costs of replacing shoud be used?)

Taxation of profit: long period (perfect competion and Profit = 0 so T = 0) short period (perfect competion and Profit > 0 so T > 0) long period + monopoly (Profit > 0 so T > 0)

14-28

Q3

profit taxQ0r max salesQ1r max sales under minimal profit constr.Qpi max profitQ0r>Q1r>Qπ

ad valorem taxQ0 max sales (no change)Q1 max sales under minimal profit constr.Q3 max profit (Q is before tax)(TRgross, TRnet)

Q

14-29

Profits Taxes (Incidence)

Profit Tax and firm maximizing profit No change, tax is borne by producer

Profit Tax and firm maximizing sales No change, if non binding profit constraints

(profit after tax is still higher then minimal demanded profit by owner)

Possible change, if profit constraints becomes operative (profit is less then minimal demanded by owner), it is not sustainable to maximize sales

14-30

Tax Incidence and Capitalization

PR = $R0 + $R1/(1 + r) + $R2/(1 + r)2 + … + $RT/(1 + r)T

PR’ = $(R0 – u0) + $(R1 – u1)/(1 + r) + $(R2 – u2)/(1 + r)2 + … + $(RT – uT)/(1 + r)

u0 + u1/(1 + r) + u2/(1 + r)2 + … + uT/(1 + r)T

Capitalization

PR ’ = PR minus all future tax liabilities

The today‘s owner bears the all future taxes

14-31

Incidence of Social security (SOC) (COPY)

Who bears the burden? Is SOC direct or indirect tax?

Determinants of incidence (pure PAYGO x FF systems), backward shaped S

Incidence in general equil. models (GEM)

14-32

General Equilibrium Models

Partial equilibrium (One Market, One Product, tax remains on this market)

General equilibrium (tax can escape its market to other market/s) 2 Markets, 2 Producers (sectors) 2 Products (food X, manufactures Y) 2 production factors – L and K

14-33

Tax Equivalence Relations

tKF = a tax on capital used in the production of food

tKM = a tax on capital used in the production of manufactures

tLF = a tax on labor used in the production of food

tLM = a tax on labor used in the production of manufactures

tF = a tax on the consumption of food

tM = a tax on consumption of manufactures

tK = a tax on capital in both sectors

tL = a tax on labor in both sectors

t = a general income tax

14-34

Tax Equivalence Relations

Partial factor taxes (C = I, I = TC = Wages + Interest)

tKF And tLF

are equivalent to (TC = W+Int)

tF

and and and

tKM and tLM

are equivalent to tM

are are are

equivalent (it can move between sectors)

equivalent (it can move between

sectors)

Equivalent( budget constr.

down)

To to to

tK and tL

are equivalent to (I =

W+Interest) t

14-35

The Harberger Model (F + M sectors)

Assumptions Behavior of factor suppliers (perfect mobility,

wf=wm) Market structure (competitive markets,

MR=P=MC, full employment) Total factor supplies (Kf+Km = K, is const.) Consumer preferences (we focus only on source (I)

side (capitalists x labourer), the uses side is same for all subjects)

Tax incidence framework (differential tax incidence, I is const.)

14-36

Assumptions II Technology (Cobb-Douglas prod. f.)

Elasticity of substitution K for L Capital / Labor intensive sector

aFL = number of person-hours needed to produce one piece of food)

aFK = amount of capital needed to …

Line of constant profit, see graph later… Pf=aFL*w + aFK*r, do same for M

if aFL/aFK > aML/aMK so F is labour intensive industry

14-37

r

w

r = (px/axk) – (axl/axk) * w (křivka nulového zisku na trhu zboží X)

r = (py/ayk) – (ayl/ayk) * w (křivka nulového zisku na trhu zboží Y)

E2

E1 E0

14-38

Analysis of Various Taxes General tax on labor (tL) (no escape to other, non

taxed sector, no shift) Income tax (t) (equivalent to tfk+tfl and all is

employed, so again no escape, no shift)

Commodity tax (tF) ?escape? Pf increase, Subst. Effect, Q of F decrease (how big? - ) factors move to other sector if F is K intensive, too many K and too less L (how much)

for M industry, r must go down, W goes up, capitalists are worst off

if F is L intensive, … laborer are worst off

14-39

Commodity tax (tF) or some tax exclusively introduced in only one sector… ?escape?

Pf increase, Subst. Effect, Q of F decrease (how big? – Part. Eq.)

factors move to other sector due to decrese of production if F is K intensive, there will be too many K and too less

L (how much?) asking for utilitization in M industry, SO r must go down, W must goes up, capitalists are worst off BUT if F is L intensive, … laborer are worst off

14-40

Partial factor tax (tKM)

Output effect (similar Commodity tax) – ambiguous with respect to who is worst off

Factor substitution effect r*gross goes up – SE, less K and more L is

demanded Total effect = OE + SE

clear ambiguous (for tkm if m is L intensive, OE

decreases w, increases r, SE decreases r and increases w)

14-41

Some Qualifications (releasing of assumption)

Differences in individuals’ tastes (impact on uses side) PIT – first impact on capitalist (progressive tax),

but later through the increase of Px also on consumers (regressive impact)

Immobile factors all burden on L or K, can not excape)

Variable factor supplies tk in long run decrease Q K, but it mieans also

decrese of productivity of L)

14-42

An Applied Incidence Study

Income Category

Average Federal Tax Rate

T/BAZE

Share of Federal Taxes

T/SUMT

Lowest Quintile 5.6% 1.1%

Second Quintile 12.1 5.2

Third Quintile 15.7 10.3

Fourth Quintile 19.8 19.0

Highest Quintile 26.5 64.2

All Quintiles 21.6 100.0

Top 1% 31.2 21.3

Source: Congressional Budget Office [2004]. These figures are based on projections that rely on assumptions about inflation and income growth.They include all tax law as of 2001.

Table 14.3 Average federal tax rates and share of federal taxes by income quintile (2006)

14-43

The Payroll Tax

Hours per year

Wag

e ra

te

per

hour

DL

SL

L0 = L1

wg = w0

Pr

DL’

wn